Axos Financial, Inc.
Q2 2019 Earnings Call Transcript

Published: 30 Jan 2019

[Operator:]

Ladies and gentlemen, greetings and welcome to Axos Financial Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now pleasure to introduce your host, Johnny Lai, VP, Corporate Development & IR. Thank you, you may begin.

[Johnny Lai:]

Thanks, Adam. Good afternoon, everyone. Thanks for your interest in Axos Financial and Axos Bank. Joining us today for Axos Financial second quarter 2019 financial results conference call are the Company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer Andy Micheletti. Greg and Andy will review and comment on the financial and operational results for the three and six months ended December 31, 2018 and they will be available to answer questions after the prepared remarks. Before I began, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statement as a result of risks and uncertainties. Therefore, the Company claims the Safe Harbor protection pertaining to forward-looking statement contained in the Private Securities Litigation Reform Act of 1995. This call is being webcast and there will be an audio replay available on the Investor Relations section of the Company's website located at axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. At this time, I'd like to turn the call over to Greg for his opening remarks.

[Gregory Garrabrants:]

Thank you, Johnny. Good afternoon everyone and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the second quarter of fiscal 2019 ended December 31, 2018. I thank you for your interest in Axos Financial and Axos Bank. Axos announced record net income of $38.8 million for the fiscal second quarter ended December 31, 2018, up 22.7% and the $31.7 million earned in the fiscal second quarter ended December 31, 2017, and up 5.4% when compared to the $36.8 million earned in the prior quarter. Earnings attributable to Axos's common stock holders were $38.8 million or $0.62 per diluted share for the quarter ended December 31, 2018, a 26.5% increase from the $0.49 per diluted share for the quarter ended December 31, 2017 and $0.58 per diluted share for the quarter ended September 30, 2018. Excluding non-recurring expenses, non-GAAP adjusted earnings and earnings per share were $39.6 million and $0.63 respectively for the quarter ended December 31, 2018. Other highlights for the second quarter included ending loan and lease balances increasing by $363 million, up 4.2% on a linked quarter basis or 17% annualized from the first quarter of 2019. Total assets remained unchanged from $9.8 billion at September 30, 2018, and up $0.9 billion from the second quarter of 2018. Net interest margin was 3.87% for the quarter ended December 31, 2018, up 11 basis points from 3.76% in the first quarter of fiscal 2019. Average loan yield increased by 9 basis points to 5.6% compared to 5.51% in the quarter ended December 30, 2018. Excluding the impact from H&R block seasonal loan products in Axos's liquidity and our subordinated debt, net interest margin in the quarter ended December 31, 2018 would have been approximately 3.83% compared to the 3.92% in the second quarter of 2018, and 3.76% in the first quarter of 2019. Capital levels remain strong with Tier 1 leverage ratio of 9.03% of the bank and 9.41% of the holding company, both well above our regulatory requirements. We took steps to redeploy some of our excess capital this quarter buying back $48 million of common stock at an average price of $28 per share. Return-on-equity was 15.29% for the second quarter of 2018 compared to 14.37% in the corresponding period last year reflecting the bank's year-over-year increase in earnings. Our credit quality remains strong with 6 basis points of net charge-offs and a non-performing asset to total asset ratio of 53 basis points this quarter. We received approximately $1 million of payments in the quarter ended December 31, 2018 for refund advanced loans originated during the 2018 tax season which offset the increase in our loan loss provision this quarter. Our allowance for loan loss represents 124.9% coverage of our non-performing loans and leases. While we have a small number of loans to borrowers secured by real estate properties located in the areas affected by wildfires and mudslides in California, our net exposure after insurance appears to minimize. Our efficiency ratio was 46.47% from the second quarter of 2019 compared to 51.47% in the first quarter of fiscal 2019, and 40.28% for the second quarter of fiscal 2018. We incurred onetime expenses related to mergers and acquisitions this quarter. Excluding $1 million of deal-related expenses, the efficiency ratio would have been 45.5% of the second quarter of 2019. We originated approximately $2.5 billion of gross loans in the second quarter, up 20% year-over-year. Originations for investment increased 35.6% year-over-year $1.8 billion, and originations for sale decreased 11.1% to $610.2 million. Ending loan balances increased by 14.5% year-over-year to $9 billion led by strong growth in single-family jumbo, multifamily, other commercial real estate and C&I finance, lender finance. Our loan production for the second quarter ended December 31, 2018 consisted of 81 million of single-family agency eligible gain on sale production, $431 million of single-family jumbo portfolio production, $182 million of multifamily and other commercial real estate portfolio production, $1.043 billion of C&I production, $42 million of auto and consumer unsecured loan production, $401 million of annual advanced [ph] loan originations, and $30 million of seasonal H&R Block franchise loans. For the second quarter 2019 originations are as follows

[Andrew Micheletti:]

Thanks, Greg. First I wanted to note that in addition to our press release, our 10-Q was filed with the SEC today and it's available online through EDGAR or through our website at axosfinancial.com. Second, I will quickly highlight a few areas rather than go through every financial line item. Please refer to our press release or 10-Q for additional details. As Greg noted earlier, for the quarter ended December 31, 2018 net interest margin was 3.87%, up 11 basis points from the 3.76% for our last quarter ended September 30, 2018. This quarter the net interest margin was favorably impacted by higher loan and investment rates on earning assets, as well as lower rates on interest bearing deposits and time deposits. Our average yield on earning assets was 5.48% for the second quarter of fiscal 2019 compared to 5.35% for the first quarter of fiscal 2019, up 13 basis points. On the deposit side, our average cost of interest-bearing deposits and time deposits decreased 9 basis points and 21 basis points respectively when compared to Q1 and in September 30, 2018. As noted earlier, we closed the Nationwide Bank deposit acquisition of $2.4 billion in deposits halfway through the second quarter. This included $1.7 billion of timed deposits at a weighted average rate of 2.26 and $0.7 billion of checking, savings, and money market accounts at a weighted average rate of 81 bips. If you assumed the benefit of Nationwide deposit acquisition for a full quarter and you remove the average loan balances and the interest income associated with the short-term H&R Block, Emerald advances and franchisee loans; the net interest margin for the quarter ended December 31, 2018 would have been 3.83%, up 7 basis points from the 3.76% net interest margin for the quarter ended September 30, 2018. Moving to operating expenses; as noted earlier, our efficiency ratio improved to 46.5% this quarter compared to 51.5% for the quarter ended September 30, 2018. Total non-interest expense for the second quarter ended December 31, 2018 decreased $2 million to $50.9 million compared to $52.9 million for the linked quarter ended September 30, 2018. The decrease is primarily attributable to a $1.4 million savings associated with normalizing FDIC insurance costs this quarter compared to the higher than average FDIC costs last quarter associated with the temporary broker deposits used to prepare for the Nationwide deposit acquisition. In addition, advertising and promotional costs this quarter declined by $1.1 million compared to last quarter primarily due to lower deposit marketing costs, lower mortgage loan lead costs, and lower branding costs. Excluding the acquisition-related expenses and the aforementioned excess FDIC expense, our non-GAAP adjusted efficiency ratio would have been 45.5% in the second quarter ended December 31, 2018 compared to 49.42% in the first quarter ended September 30, 2018. Our depreciation and amortization expense was approximately $3.6 million in the second quarter of fiscal 2019 compared to $3 million in the first quarter of 2019, and compared to $1.9 million in the last year second quarter ended December 31, 2017. The primary drivers of the sequential and year-over-year increase in our depreciation and amortization expenses, our amortization and intangibles associated with the Epiq and the Nationwide deposit acquisitions which were $900,000, $700,000, and zero for this quarter, for the last quarter, and for last year, respectively. Also, software depreciation as a result of deploying the universal digital bank and the related systems was $1.8 million, $1.5 million, and $1.1 million for this quarter, for last quarter, and for last year, respectively. With the COR acquisition closing this month and the WiseBanyan acquisition expected to close some time in our fiscal third quarter of 2019, we expect our depreciation and amortization expenses to increase over the next several quarters by an amount between $1.5 million and $2.2 million per quarter. With that, I'll turn the call over to Johnny Lai.

[Johnny Lai:]

Thank you, Andy. Adam, we're ready to take questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Brad Berning from Craig Hallum.

[Brad Berning:]

I wanted to follow-up on the acquisition a little bit. Can you talk a little bit more about what you think about the ROE profile and the growth profile of the company after you get things all put together? How do you think about Axos in the out years as this gets put together?

[Gregory Garrabrants:]

Are you talking specifically about COR or the aggregation of all of it?

[Brad Berning:]

I'm talking the aggregation of all of it. You've got a lot of good moving parts here and I'm trying to think about how you're putting this picture together in your head.

[Gregory Garrabrants:]

I think right now from a standpoint of intermediate term modeling, I think we've given enough information to allow you to see these parts separately and make reasonable estimates with respect to how they would come together. Over time, we expect to grow COR organically. The value of that growth will be partially dependent upon interest rates. Higher interest rates are better for this business. Lower interest rates are not as good. We have other parts of the business that may operate differently, such as agency mortgage banking. There are a lot of assumptions that have to be embedded into this. The question of how much growth or how much enablement of growth that the overall and eventual integration of digital wealth management through the universal digital banking platform to our customers will have is very difficult to ascertain because we obviously have growth projected in the out years that is fairly robust. So, part of this and these acquisitions is to ensure that we're able to meet those objectives as they currently are. It's also difficult to know how pricing will be impacted and how retention will be impacted by the addition of these services. We believe that clearly from the research that we've done, that it will lower the cost of acquisition, increase retention, reduce the sensitivity of the checking accounts within our deposit base. I think it's very difficult and I don't think you should be building those numbers into the out years of your model because we have to prove we're going to be able to do that effectively.

[Brad Berning:]

All fair points and appreciate the thought process, we'll continue to monitor things as we go. One other follow-up is as you think about the IT investments to bring the new acquisitions on board and you think about the opportunities to not just integrate but expand the investments and opportunities with those acquisitions, how are you thinking about efficiency ratios as we progress through the intermediate term here? I just want to make sure we understand how much of that to perpetuate in the model but also think about the opportunity set you might want to invest in.

[Gregory Garrabrants:]

I think from a bank perspective, thinking about modeling the banking efficiency ratio where it is for the next year is the right approach. With respect to COR, we have the numbers with respect to that specific efficiency ratio for the purpose of being able to look at those segments separately. We will be breaking those out on a separate basis. If COR ends up growing well, it will grow in a way that will increase our ROE but would decrease the overall holding company or increase the overall holding company's efficiency ratio. That's a good thing given that efficiency ratio is utilizable for banks and it's much less utilizable for essentially selling software as a service to clients in a very capital-efficient business. So, it really depends on the mix of growth. I think right now, just for the next year, assuming that COR essentially is at stasis, although we hope to do better than that is the right approach. Thinking about the bank in its normal growth trajectory with the efficiency ratio we have currently is the correct approach. If you're asking how are we going to do a lot of the things we're doing -- we've invested a lot on the technology side. We have a pretty big team now. That team has delivered a lot of product, although they have a pretty aggressive schedule this year. I think that we can work within the existing structure that we have reasonably well with $1 million here, $1 million there in order to deliver on the strategic vision we have.

[Operator:]

Thank you. Our next question comes from the line of Austin Nicholas from Stephens.

[Austin Nicholas:]

On the margin outlook, could you remind us of what that is heading into '19 as you layer on these different deposit businesses off that 3.83% number?

[Gregory Garrabrants:]

I think that looking forward for the next 12 months, you should use the guidance we've historically given. The 3.80% to 4% range excluding Block impact -- I think that's the reasonable level to look for in the next calendar year.

[Austin Nicholas:]

Maybe just on the Epiq business; can you give us an update of how many deposits have come over and think about the trajectory of the full opportunity of deposits coming over in '19?

[Gregory Garrabrants:]

Yes. It's about $200 million that's come over now. We're continuing to make those transitions. Ultimately, it depends on several factors. There is roughly $800 million. Some deposits are higher cost than some of the others. Remember, we also do lose some component of fee-based income as those deposits move from a third-party bank to our bank. However, they are a net benefit to us because we are receiving less from the partner bank than the cost of the deposit that we are replacing on a marginal basis.

[Operator:]

Thank you. Our next question comes from the line of Michael Perito from KBW.

[Michael Perito:]

I wanted to start on the loan growth side. It seemed like the C&I book had some really strong growth in the quarter. I was looking at the Q filing. It looks like most of that was in the -- I believe you guys incorporated within your C&I portfolio the warehouse and other line -- I don't know if that's wrong or right, but I believe you were including that in your prepared remarks when you mentioned the C&I growth. Do you have the breakdown of what drove the big year to date growth in that line item?

[Gregory Garrabrants:]

So, the year to date growth was about -- if we go back from the second quarter of 2018 and then the second quarter of 2019 fiscal, there's about 24% loan growth. That was really broken up across a variety of categories. We had growth in the lender finance side, the real estate specialty lending group as well. So, I think that it was reasonably balanced a little bit on the side of the real estate specialty lending business.

[Andrew Micheletti:]

I can give you the components that make up that line item.

[Michael Perito:]

That would be helpful, Andy.

[Andrew Micheletti:]

Included in single-family lender finance is $172.8 billion. Single-family secured branch specialty is $120.2 billion. Then when we look at warehouse number -- it's $220 million.

[Michael Perito:]

As it relates to the loan yields, they've done fairly well over the last few years, but the mix of the portfolio has changed a little bit in that time. I'm curious if you could give us a sense of where you think some of the stronger loan yield performance has been coming from. Has it been being able to get increased incremental yields on new single-family production? Has it been the addition of some of the C&I stuff? Any color would be helpful.

[Gregory Garrabrants:]

For single-family, we've been able to maintain originations and grow that book. For every rate increase the Federal Reserve has made, we raised our rates 12.5 basis points. Call that a 50% loan beta, but that's loan beta on incremental production, not on the actual static loan book. For multi-family, I think it was the same thing, 12.5 basis points except one we did not raise rates. The vast majority of the C&I production other than the equipment leasing is variable and floating rate that would float 100% with an index, usually LIBOR. The equipment finance loans and the warehouse lines and the specialty real estate generally have higher loan yields than the single and multi-family. So, any next shift benefits in two ways, not only the loan beta, but also from a remix of the product.

[Michael Perito:]

That's helpful, thanks. Go ahead, Andy.

[Andrew Micheletti:]

I can give you an example of the largest driver. C&I and lender finance -- June, the point in time yield was about 7.13%. At the end of this quarter, it was 7.69%. It's a good rate plus it's living with rate hikes.

[Michael Perito:]

On the expense side, obviously, you guys have layered a few different businesses here, but given that they were in some cases newer partnerships or business, not a lot of cost savings. As you guys looked at these businesses you're bringing on, is there a point over the next couple of years where there could be some synergy opportunities once you get a better handle on what's required to operate these platforms and any redundancies you can automate or stuff like that? Do you think they're fairly efficiency run as they stand today and growing the revenues longer-term is the best opportunity?

[Gregory Garrabrants:]

I think there are opportunities to get efficiencies from an operational perspective out of both Epiq and COR which are the largest investments in personnel. However, those efficiencies will essentially be put back into doing things a lot better and quicker associated with these businesses. So, for example, on Epiq, we're going to spend a lot of time making sure we're the best in class in that business so we can win more trustees. We've got to go and make sure the platforms are efficient, customer service is best in class, then the growth will come from the trustees. COR will be the same thing. We'll be looking to go up market and in the process, the folks that are doing things manual will be spending time on GAAP analysis with respect to how to go up market and win bigger business. I don't think it would be a good idea to put in your model some sort of, "Hey, we're going to be able to cut COR's cost in year two," or something. That's not what it looks like.

[Operator:]

Our next question comes from the line of Gary Tenner from D.A. Davidson & Company.

[Gary Tenner:]

A question regarding WiseBanyan; I wonder if you could walk through your thoughts on how it comes to monetizing that platform rather than offering it as a value-add, as a way of customer acquisition, etcetera?

[Gregory Garrabrants:]

There are several ways of monetizing the platform. The first is the customer acquisition side. Their cost of acquisition has historically been lower than our cost of acquisition with respect to gaining a new customer for the platform. Now, they've been very attractive on the pricing side with respect to the platform, which has assisted them in that customer acquisition cost. Thinking about how to tie in the requirements for the checking account with direct deposit with the pricing strategy of that customer acquisition is an area that we've done a lot of modeling in and looking at. Next, there are opportunities to provide basic levels of services and then to have add-on services associated with that that you can charge a fee for. So, there's a base level service being offered at a value proposition and then incremental services being offered that allow the customer to choose where they'd like to play. That would be a fee income generator. I do think that there's also the ability to monetize customer from a pricing perspective with respect to the checking side. The whole goal of the long play here is to be able to control the platform so that the services of the platform are sufficient enough from a value proposition that the checking customer becomes less rate-sensitive. Clearly, there are some competitors that have done an amazing job of this. Charles Schwab has done an amazing job. As digital banking competition increases, it's increasing in this -- call it the first wave way, which is what we helped pioneer, but the second wave way is the path forward. So, that path forward is about integration of services, customer experience, personalization of the recommendations and sufficient services such that the overall value proposition is more valuable than picking it apart. I think that we've got those pieces in place and it's part of the -- we've been eyeing the robo-advisor business for a long time, but part of the problem is the value we wanted to provide was hampered by our discussions with third-party clearing companies, who said, 'well fantastic, we'll meet your pricing demands but we want all the deposits'; and that doesn't work for us. And so now those pieces are in place, the vertical integration, so therefore we can go and make that happen. It's not straightforward and it's not a next quarter exercise but it's all in place to be able to make that happen over the next couple of years.

[Gary Tenner:]

I'd always wanted to ask to make sure I heard correctly, the modest increase in NPAs this quarter in the single-family portfolio -- did you say those were in areas that were impacted by some of the wildfires and loss content looks pretty minimal. Did I hear that correctly?

[Andrew Micheletti:]

No, there was primarily one loan for $7.5 million that went into non-performing single-family, it's about 55% LTV, no real long-term issues with it. There were no issues in non-performing associated with the fires of any significant nature.

[Operator:]

Our next question comes from the line of Andrew [ph] from Sandler O'Neill.

[Unidentified Analyst:]

A follow-up question here on the expenses; some good cost control this quarter but it sounds like the amortization and/or depreciation might step up here in the first quarter, and with COR closing a little bit earlier than you may have expected. What's the right expense run rate to build off here in your third quarter and going into the rest of the calendar year?

[Gregory Garrabrants:]

With respect to COR depreciation, that is included in the number that we provided with respect to the net income. So it's not that net income and that benefit associated with the accretion, we're including the expected increase in the depreciation cost, so that's an element that you have but that is included, so it's not incremental with respect to what's happening with COR you'll still have that 6% annual accretion associated with that business. And so the closing of it early, it will -- sort of midway through a quarter, that obviously has to be prorated but that piece of it -- the other pieces of the increased depreciation, I mean, those are just increased costs that will flow through the P&Ls.

[Andrew Micheletti:]

And Greg gave guidance on general overall efficiency for the year -- as you know, this quarter's efficiency will be significantly better because of the block income. But of the $1.5 million increase, about half of that will be COR intangibles that we're estimating. And as part of the reason I gave a range from $1.5 million to $2.2 million, we haven't done the final valuation analysis to come up with the exact intangibles, but about $1 million of that is COR. So it's not a huge number but the broader point was that depreciation has increased a little bit each quarter because of the amortization of the software. And -- so we are expecting that to continue to increase, we just wanted to be clear on that. But I think the overall guidance of looking at it full year on the banking side in the 40s range is the right way to think about it and then take COR separately which will be more like a 70% number in efficiency.

[Operator:]

[Operator Instructions] Our next question comes from the line of Edward Hemmelgarn from Shaker Investments.

[Edward Hemmelgarn:]

Greg, I just have an additional question regarding COR Clearing. And also, congratulations on your acquisitions and also on the opportunistic share repurchase. But with COR, you're going to get a benefit from having greater equity. What other opportunities or how much do you think that may help COR in getting new business versus other opportunities that you may have within the pickup business for COR? I mean, if you could kind of elaborate on that a little bit more.

[Gregory Garrabrants:]

Sure. I do think that's an important point. I do think at a certain point, right, having the backing of Axos Financial with respect to it's capital base will certainly increase the conversation. There are also opportunities to optimize the business across, there is obviously a number of different ways that clearing companies make money, and we've been digging into the optimization of the existing customer base; we do think there is some upside there. So there is upside from just the -- we have capital, there is upside from some of the cross-pollination with banking services without I think having to do much infrastructure work. And I will say that there is an absolutely felt need within let's call the middle market of the introducing broker-dealer segment that clearing companies are not particularly responsive, they are not attuned to the needs of what they would consider to be smaller customers but would be good customers for us. I've been out doing some selling, you know, you've got, I'd say the doors are being swung open and there is some pretty big opportunities on one hand, on the other hand, the issue is that these contracts are longer term and that the conversion element of these are significant. So the great part is that you get to -- it's hard to lose customers, and it takes a long time to get them as well because they are often subject to contractual obligations and have the burden of having to sometimes repay for accounts associated with transfer. So I think it is -- I think there is opportunity there, absolutely, and we'll be working on it. I know it's not an overnight set of opportunities but I was out at one conference just kind of ahead of the game and the excitement was palatable. I mean, people are very interested in having a company that has the technology that we have. I mean, think about for example, you've got an introducing broker dealer and the way they are opening accounts is paper-based and all of a sudden they have an account-opening system where they can take a driver's license and a picture of their face and open it, and that could be pushed through that network, right. I mean, there was a lot of interest in that, getting all those things done and getting them implemented and people using them is a different story but there is a ton of opportunity here.

[Operator:]

Thank you. Our final question comes from the line of Steve Moss of B. Riley FBR.

[Unidentified Analyst:]

This is Zach [ph] filling in for Steve today. On the upcoming tax season, is there any outlook or expectations for the refund advance product relative to last year?

[Gregory Garrabrants:]

We have an understanding of that but that wouldn't be something that we would comment on. Just -- we've historically in any year never comment on the volumes associated with those elements, just frankly, because they also -- they impact what people would be able to drive about H&R Block and any kind of variance we don't think is material for us.

[Unidentified Analyst:]

In terms of credit, is there anything you all are seeing from the trenches that's worth noting? If there are certain areas that might be getting too frothy, if there is anything notable you guys are seeing on that end?

[Gregory Garrabrants:]

In general, I think there has been some non-bank competitors that have entered certain mortgage spaces and I think they are doing things that are well outside our credit box. They are doing them generally at significantly higher rates but also higher loan to value ratios. So, that's one area where we see a little push on the credit side there. I don't think we spend a lot of time -- if we do what we do well, then I think we can continue to have reasonable growth and continue to increase our assets and not have to follow that. So we haven't done anything differently and I'm not seeing anything that raises any major panic.

[Operator:]

Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn the floor back over to management for closing comments.

[Gregory Garrabrants:]

All right, thank you, everyone. We'll talk to you next quarter.

[Operator:]

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your line at this time. Thank you for your participation, and have a wonderful day.